Transparency options are all greyed out?
I didn't realize you moved this to a new question...try this:

In the Material, make sure you select 'Transparency' with Z Transparency under Render Pipeline Options. 



Also under 'Options', turn on Face Textures and Face Textures Alpha. Under the Texture itself, make sure 'Use Alpha' is checked in the Image section. 



Oh also connect the Alpha from the Material to the Output as before.